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"Target 2 imbalances as you describe represent little more than accounting conventions between the central banks."

___________________________________

No, they don't.

Since you seem to have difficulties telling DEFICITS and SURPLUSES apart, let me help you out one more time:

Target 2 deficits indicate to which extent a country's central bank is unable to pay their citizens' foreign bills. Put more simply: Italy's 300 billion euro debt via the target 2 system is nothing else but bills for German and Dutch products left unpaid by the Italian central bank, and for which the Bundesbank and the Dutch central bank have reimbursed the German and Dutch vendors, and are now waiting for the Banca d'Italia to settle its bills. In the US, a similar mechanism exists between FED districts – with the small difference, that at the end of EACH QUARTER, those bills are settled in real assets.

Bottom line:

ITALY IS LIVING ON CREDIT FROM THE EURO ZONE'S MORE SOLVENT NORTHERN HALF, AND THE TARGET 2 BALANCE SHOWS TO WHAT EXTENT.

WHY DO YOU THINK ITALIANS ARE THE WORLD'S LARGEST HOLDERS OF GERMAN BUNDS.

YOU ARE LIVING ON OUR SAVINGS - JUST AS DEUTSCHE BANK HAS USED ITALIAN SAVINGS FOR YEARS TO INVEST IN:
A) AMERICAN TOXIC MORTGAGE-BACKED SECURITIES
B) OVER-LENDING TO GERMANY'S REAL ESTATE SECTOR
C) OVER-LENDING TO GREECE, A COUNTRY WITHOUT A CENTRAL LAND REGISTRY
D) OVER-LENDING TO IRELAND

It doesn't look like it when you are literally shouting. Try to use your head and not your guts for a change. LOL

1) If you really worked in a bank you should be able to tell deficits and surpluses apart – and the target 2 mechanism indicates that the Banca d'Italia owes about 300 billion euro to its euro zone partners. That's a whopping number, I know. (Maybe it'd freak me out as well, if I were you.)

2) It is not primarily Italian capital flowing northwards, but Geman, Dutch etc. capital returning home. Before the euro's introduction, Germans invested 2/3 of their savings at home, and 1/3 abroad, most of it in the EU. The figures switched afterwards, before they returned to their old normal after too many investments in Southern Europe flopped. What has stopped is the temporary (1999-2008) easy money supply for Southern Europe following the euro's introduction.

3) The biggest holders of German "Bunds" are the Germans, btw, followed by Swiss investors - not Italians.

4) All of which begs the question: Do facts still matter in your world?

"One friendly-looking, moustachioed gentleman showed just how ugly relationships can be, even among partners: "Get out of our country, bitch," read the sign he was holding."

The other article I would recommend to you regards another problem I have been writing to you about for months: there is no "competitiveness" problem in Italy - there is a (traditional) problem with energy imports as we have no coal or petroleum here and we DECIDED TO EXIT NUCLEAR POWER 25 YEARS AGO. We are therefore a generation ahead of Germany in dealing with this problem - which are sturdy Teutons are discovering is no trivial matter:
"Germany plans to abandon nuclear power by 2022, but its government hasn't been doing enough to ensure that the project succeeds. Needed infrastructure and technology is lacking, and coordination is a mess. Meanwhile, weary consumers are paying more for electricity, and the supply is in jeopardy."

Yes Josh, we are laughing in Italy. Our ubermenschen neighbours to the north are discovering why abandoning nuclear power was no doddle for the peninsula. (We were the world's third-largest producer of nuclear energy in the 60's, behind the US and the UK).
Do you really think it a coincidence that Germany's export surplus to Italy has evaporated exactly as Germany abandons nuclear power?

what makes ME laugh is the childish joy with which you blow-up non-events if only they offer a ray of hope.

1) So Italy "DECIDED TO EXIT NUCLEAR POWER 25 YEARS AGO"? Then why does nobody around the world cite Italy as an example for this process? Could it be because Italy never had much of a nuclear energy production to begin with?

2) So you had a measle 12-million-euro trade surplus with Germany in ONE of the year's statistically recorded 7 months? Congratulations. What happened in the other 6? Thanks – case closed.

(Don't get me wrong - I'd actually welcome an Italian trade surplus with Germany, as it would help rebalance the eurozone's economy.)

3) As I've explained to you earlier, competitiveness is NOT an equivalent of trade surplus. Otherwise the US would be uncompetitive, and a lot of third-world countries would be high up in all rankings. Competitiveness includes other factors, such as a country's governance, rule of law, corruption, infrastructure, and so on – and in some of these fields, Italy's scores are abysmal. "Il sole 24 ore" now addresses the Italian lack of competitiveness and how to overcome it in nearly every 2nd of its english-language comments – here's the link:

No, they are in your (willful mis-)interpretation non-events - although I grant you some confirmation of recent trends is needed.

1) There were four power stations, but more than four reactors. In the 1960's, this represented more nuclear production than Japan, Germany or France.
The reason why Italy is not cited is three-fold:
a) Because Berlusconi has so badly hurt Italy's reputation abroad (to undeservedly low levels);
b) Because the fact that the world must de-nuclearise is still not even accepted in China, the US, the UK and France (and yet, the recent Japanese and German decisions demonstrate Italy was right in 1987 to vote to abandon nuclear power.)
c) Because the two major economies abandoning nuclear power are Japan and Germany, our former Axis allies - who have NEVER forgiven us for losing the war for them.

2. July is the most recent month for which we have data; August data will be released in another 10 days or so.

The previous six months before July demonstrated a steady trend of our improving trade balance, including a steady evaporation of the German surplus. Trade data is rather stable and not erratic.

3. Are you actually reading the Sole24Ore articles? No, they are not mostly about "uncompetitiveness"; they are mostly about economic issues - which is not the same thing ;-)

"Because the two major economies abandoning nuclear power are Japan and Germany, our former Axis allies - who have NEVER forgiven us for losing the war for them."

- I have not the slightest idea what WWII could possibly have to do with exiting nuclear power; more generally, I have never heard anyboy claim Italy "lost the war for" Germany and Japan. (The Italian theater was not exactly the most important one.) But then again, I don't speak Japanese.

"Are you actually reading the Sole24Ore articles?"

- Yes, I am - a few per week. Interesting. And the debate on how to improve Italy's competitiveness is front and center, as it should.

I'll be off for a while. So you'll have to shout someone else down for a change;-).

I thank you for reading IlSole24Ore. Although it is owned by the Italian Confederation of Industry and is therefore partisan, it is really a quite decent newspaper with a history of very detailed articles. They have long been the paper of record for the publication of new commercial laws. Much of the paper is quite "grey", but is a reliable source of facts.
Its circulation of over 300,000 is also quite more than that of the Financial Times in the UK and I daresay offers better national news, that is to say, more detailed articles, than what one reads in the FT.

Referring to Southern Europe's economy as “olive oil, wine, and hotel rooms” is an ignorant and scornful remark one would expect from the Daily Mirror. We are not immune from this type of prejudices in Southern Europe, we have similar magazines that often refer to the Brits hinting at their low level of personal hygiene, citing the lack of appropriate washing facilities (a.k.a. bidets) in British toilets, but I expected the Economist to be in a different league. Maybe it's time to delete this bookmark from my browser.

WOW. That's quite an admission, but wholely logical under the likely circumstances.

Now this blog, at least, will have to start making reasoned speculations as to what the likely scenarios for a breakup and fallouts from them are. Will it be an orderly or unorderly breakup? Will Germany just leave or be kicked out on its own leaving a suddenly competitive "Southern" Europe economy but with financial firefighting by a country wracked with bad banks and huge central bank currency obligations to the rest of Europe?

In fact, what I most worry about is the psyche of investors and, indeed, the average worker/consumer if this most "sacrosanct" symbol of European identity breaks down.

How will investors suddenly feel about the safety of future debt repayments if countries that have massive government, public, and private debts suddenly devalue in a very shaky world economic environment? How can Germany buy suddenly cheaper Euro goods when they're going to have massive bank restructurings and likely massive public worries about jobs, competitiveness, and the future of pensions from a country with a sudden huge increase in liabilities? How will the investors in the US cope with seeing their investments in the broken-up Europe probably drop substantially in value with currencies dropping versus the dollar?

I worry how an Euro breakup will suddenly bring the issue of massive debt and deleveraging to the conscious forefront of investors and the public.

A well-written article - and yet full of holes:
1) Speaking of the "South" is more misleading than helpful. The Italian economy is almost half of the entire south - and the analysis offered here does not much apply to Italian problems.
Mostly, there was never any large transfers of northern European money to finance deficits in Italy - or Portugal.
That point regards Greece and the Spanish real estate bubble.
Greece is Greece - a case of State corruption and incompetence on a scale unmatched anywhere else in the developed world.
The Spanish real estate bubble happened for a number of reasons that I doubt will be repeated in the future, now that the damage is before the eyes of everyone.
2) A transfer union? Why is it that British propaganda has done everything to convince the world, both inside and outside of Europe, that either Europe forms "a more perfect union" (as the Americans would say) or everything collapses? The problem is that the Euro's continued existence has been called into question publicly and credibly, thanks to two factors:
1) Incessant British anti-Euro propaganda
2) German doubts, which have always existed
British anti-Euro propaganda needs to be countered with a unified message coming out of Brussels - but Jens Weidmann is still blocking a unified ECB voice. And, Mario Monti's government needs to stop dragging its feet on approval of the Tobin Tax to hit the London-based speculators. (This is now being adopted as an official position by the Left in the run-up to elections). We also need to look at punishing (obviously, indirectly) those in London who helped corrupt Greek finance ministers hide so much debt successfully.
A re-capitalisation of Spanish banks, a reduction in deficits around the South, new privatisations, falling interest yields due to the new ECB policy (and re-purchases of national bonds by the Italian Treasury, the largest in the South) - all these strategies together will work to turn down the "heat" - and pull the rug out from the Euro-sceptics.
3) No, northerners do not need to buy southern products - they have never consumed much olive oil and I doubt they will start doing so tomorrow.
The South is boosting exports elsewhere. We must hope for recovery in northern Africa and the Middle East, centuries-old southern trade partners. And the South needs to increase exports to Asia/China - which is happening.
The Italian trade balance has swung strongly from a 4% of gdp deficit two years ago into what looks like it will be a 1% surplus this year. In the meantime, all the negative publicity (from London, thanks again) is certainly not helping exports of FIATs and SEATs.
The biggest North/South trade imbalance however is due to Italian energy imports from France and Switzerland. The balance is slowly improving, as domestic alternative energy production has grown sharply. And this leads to,
4) Energy - the fatal, unmentioned flaw of your line of argumentation.
The reputation of Italian competitiveness got into trouble over the last few years because Berlusconi wasted too much time with his return-to-nuclear-power bluff.
Almost ten years were wasted when we should have been concentrated on boosting wind power. We have finally been doing this over the last 2 years - and not coincidentally our trade deficit has been erased.
Portugal looks so much more competitive also because 50% of its electrical energy is produced from domestic green sources. Spain too has invested much.
I would ask the author if he is old enough to remember the Oil Shocks of the 70's. Our real economic problem in the Euro-zone is the lack of domestic petroleum reserves and the post-Iraq spike in world prices. Since the UK has North Sea oil, it is easier for British propaganda to attack the Euro-zone for a relative weakness deriving mostly from Anglo-American military policy in the Middle East over the last decade. (And now we have agreed to boycott Iranian oil, even though our economy can not easily afford higher oil prices).
Easy to laud the Polish economy for its strong performance outside the Euro during the crisis- but
1) devaluation cannot be a permanent strategy (it too has its costs - particularly in R&D)
2) Poland has Silesian coal - and has refused to ratify Kyoto accordingly
3) Poland is the largest net recipient of European aid (Italy is one of the largest net contributors, even on a per capita basis).
As Germany exits nuclear power, (as Japan exits nuclear power) as ever more smaller European countries fall into line and exit nuclear power, southern wind, solar and biomass (olive oil sansa, for example) energy production will become more important.
BTW, Germany and Japan together will produce a trend. We have not yet digested the full import of Fukushima, because the damage is not finished. But the result of that disaster will be a more general retreat from the nuclear option- which will spread to the US, I believe. France and China will resist the trend - but not forever.

How on earth is it now suddenly the UK's fault that the EZ is in trouble? Is the UK so powerful that because they point out some problems in the EZ construction (that are being pointed out be a lot of other people too), that it suddenly makes those faults THEIR doing?
If what the UK says wasn't the truth... would people take notice?

The EZ is basically in trouble because you simply can't have a currency union between widely different countries without having an official transfer mechanism (plus some other factors the EZ hasn't got either, see 'optimal transfer union').
This is a (fatal?) flaw in the euro construction, and is the base cause for all the current symptoms (like the debt and interest rate problems some countries have).

The EZ countries MADE that euro construction, against the advice of a lot of economists at the time, AND the UK warned that the construction wouldn't work... yet now you say the UK is so much to blame?
Note that the UK IS a currency union, and they DO know how they work (and doesn't work)!

It is true that the UK doesn't want to pay for restoring the EZ, but WHY SHOULD THEY? They didn't create the mess! They're not EZ members, and they warned against it in the first place!

Seriously, stop looking for scapegoats and realise whose fault the problems are! The EZ countries, and the EZ countries ONLY!
THEY created a (fatally?) flawed currency union, and are now unable/unwilling to fix it!

There is some 30% truth to what you say. Germany in particularly seems unwilling to fix it or to let others fix it - in its unwillingness to spend even a cent of its own money.

But you ignore - and I repeat - that the epicentre of the crisis is Greece - and the concealment of over 50 billion of Greek debt was beyond the abilities of imcompetent ministers in Athens. These operations required the assistance of London bankers - who therefore conspired against Brussels and the EU.

Where was the Bank of England when all this was happening? Why was it not performing its monitoring duties?

Actually, they probably were monitoring these activities and approved.
And then, Prime Minister Cameron says "the Euro is none of our business and we will contribute nothing to Greece" - even though without London bankers the Greek mess was impossible to produce.

Please note that the company who helped Greece cook their books was Goldman-Sachs, which is an American company with their HQ in New York.
Please point your guns across the Atlantic and accuse President Obama instead...

Even if they HAD been a British company (which I repeat they're not), that would not make any of their actions the responsibility of the UK government, and thus not the UK.
If a company commits a violation of the law, the government of that company isn't normally responsible...

Your (very weak) argumentation actually re-points the finger of blame BACK at the EZ countries, since they all knew that Greece WAS cooking the books (together with Italy and most of 'Club Med'), and chose to go ahead with the flawed project anyway...

Germany has so far put up money or put out guarantees for about 700 BILLION euro (this include TARGET2 balances)... I hardly think that qualifies as 'unwilling to spend a cent'... They're unwilling to just pay for 'Club Med' continuing their vacation with an open check book, and that is rightfully so.

And if you want to say that Greece is 'the problem', then all the EZ has to do is expel them and all will be good... But then Spain and Portugal will follow, then Italy, Ireland, possibly Belgium etc.
Thus Greece ISN'T 'the problem', but the entire EZ is wrongly constructed...

I see a pattern in your 'argumentation' and the way the countries put forth theirs. Both keep pointing at 'someone else' as the bad guy and refuse to accept the responsibility that is rightfully their own, and the EZ countries (especially the Southern ones) also keep wanting 'someone else' to pay for their problems.
The EZ countries created the euro, full well knowing the flaws in it, then continued for 10+ years without fixing the flaws, and they're STILL not fixing the flaws.
The responsibility for the mess, and the responsibility for solving the mess, rests 100% on the EZ governments, and thus on the EZ populations. No amount of scapegoat attempts avoid that, especially weak ones as the one you put forth here.

Your conspiracy theories belong on far less reputable web sites than The Economist!

Excuse me, I know GS was the most involved -
And then Goldman Sachs says "That was our London office. We here in New York knew nothing about their activities..."

GS London is under the monitoring of the Bank of England, not the Federal Reserve.

Also, it is not a question of blaming others. Obviously corrupt and incompetent Greek ministers are the most to blame - along with those who supported them.

But, there is blame enough to go around for everyone here; in the meantime, the Greek people most certainly are paying - the others no.

Germany "putting up money" is a fairy tale told by the German press to self-righteous German citizens.
Not one cent has been gifted and any monies actually disbursed have been lent out at a profit. Yes, some money has been lent (far less than you think). If the monies were substantial, there would be an increase, not in the German deficit (they are not spent) but in total German public debt (those monies are however lent - and borrowed). So, where is the effect on German debt of those "700 BILLION EUROS WE GERMANS HAVE PUT UP". That is almost 25% of German gdp - I don't see that public debt rising...

Throughout this crisis the Germans have CONSTANTLY thrown in the faces of the Euro-zone, their POTENTIAL costs as opposed to the PIGS REAL costs and pain. You will not get any sympathy from Italians.
We did not lend to Greece - and therefore prove it was not necessary to over-lend.
Our banks did not lend to Ireland or the Spanish real estate market - and therefore prove it was not necessary to over-lend in those areas.
Our banks were not involved in LIBOR manipulation - and therefore demonstrate not all European banks were involved.
Our real estate sector had no bubble - unlike Spain yesterday and Germany today - and therefore prove it was not necessary to create a bubble in the wake of the Euro.
Our banks did not participate in investing or distributing American toxic mortgage-backed securities - unlike Deutsche Bank - and therefore demonstrate it was not necessary to participate to make profits.

Neither the Bank of England nor the Bundesbank are admitting to their monitoring failures.

Look into how TARGET2 payments work, and you'll see how much Germany has put up...
If Germany HADN'T put up that money, then Greece, Spain and Italy (and more) would now have defaulted!

And TBH why SHOULD Germany pay more than guarantees? THEY were not the ones who ran up the Greek or Italian deficits, and THEY were not the ones who allowed the property bubble in Spain to run amok and the Spanish regions to go on a spending spree.
It's the same old story when someone gets into trouble: "I'm in financial trouble! Somebody else must pay!"
The euro was not created to allow countries to run their finances irresponsibly and then be bailed out by the ones who didn't, thus the clause in the ECB charter stating 'no bailouts'.

And 'yeah right' to GS claiming their US office didn't know anything. In cases like that, the HQ WILL know!

There is also the question whether their actions were actually legally wrong...
Greece being a sovereign nation means THEY are the ones who're the last judge on that, and they obviously thought it was right to deceive their EZ partners. That those EZ partners then deliberately closed their eyes to the Greek deceit makes it even more their fault.
All GS was really asked for was to put up some accounting methods that would put certain money in certain accounts, and certain deficits and obligations in others. ALL countries use different methods for this, though usually when comparing they choose some that are more or less the same, but the use of different accounting methods are not unique to Greece (Italy did the same when they joined the euro, though not to the same degree).

Also note that BOE and BBG are completely independent from the governments of their countries, thus the countries are not responsible for their monitoring. Central bank oversight of banks and accountants is also limited in ALL countries (well, maybe except some communist dictatorships) since they simply can't do it. Mainly they monitor some general stats like every 3 months, and then take action when someone breaks the rules. AFAIK nobody has taken legal action against GS, which must mean that their actions were actually legal...

In the end, the blame falls on Greece who chose those accounting methods, and the other EZ countries who deliberately ignored they were not the correct ones.
That last bit is the one that put the blame squarely in the EZ countries corner.

To blame the one big EU country who argued that the euro was a bad idea that wouldn't work, and chose to stay out of it for that reason is responsibility-avoidance of the first degree!

I think there is only a very few ways this will end...
1. Some of the efficient countries leave the euro because they won't pay.
2. Some of the inefficient countries leave the euro because they can't face more austerity.
3. Complete EZ explosion...

What WON'T happen is Germany/Finland/Holland suddenly accepting to pay for Club Med. Thus those countries face years, maybe decades, of austerity and unemployment. How long do you think they'll accept that before choosing option 2?
I suppose there is an option 4... that the EZ decides to end the experiment and dissolve the euro in a controlled fashion, but I think there are way too many politicians who've bound their prestige in it for that to happen. Too bad really as it would be the best solution...

The Target 2 mechanism is a perfect example of why we Italians should send the Germans to hell in a handbasket. A perfect example of how only Germany is profiting from the Euro - because the outside world views the Euro as Germany's currency.

Target 2 imbalances as you describe represent little more than accounting conventions between the central banks.
In the meantime those are REAL MONIES going from Italy to Germany.

So don't even waste your breath telling me about Target 2 imbalances. Without the Euro, Italian savings would not be headed into Germany, there would be no imbalances and Germany would not be able to finance their debt instruments for free.

Italy is the country paying the most - PAYING - to keep the Euro together. We are the ones suffering the most. If we leave, our economy takes off and Germany's collapses. But we have no intention of leaving because the EEC was founded by the Treaty of ROME, not BERIN, PARIS or THE HAGUE. We are the guardians of European Unity, not the Germans.

And, you will notice, Mario Monti and Mario Draghi are leading the European Union today, not Merkel.

In the meantime, Finland for all its virtue has not received a cent of foreign investment in five years. And the Netherlands (the Bundesbank's poodle) is drowning in private debt.

"What WON'T happen is Germany/Finland/Holland suddenly accepting to pay for Club Med. Thus those countries face years, maybe decades, of austerity and unemployment"

What a load of self-righteous horse manure. Please go and fertilise your sugar-beet fields with it.

The Italian government has just revised its estimates to reflect the worsening economic context. It is believed we will achieve a deficit of just over 2% this year, and below 1.5% for next year. The Netherlands is expected to have a deficit over 4% this year and not reach this year's Italian levels until 2014.
Denmark is set for a 4% deficit this year and a 1.7% deficit next year.
Sweden is estimated to achieve a deficit of 0.3% this year and 0.8% next year (although the government is offering to EXPAND the deficit to 3% if other European countries will do so).
Finland is estimated to have a deficit of 1.3% this year.

Therefore, Italian deficits are no higher than the average of the "virtuous" North. This despite a larger overall debt load whose interest expense consumes well over 5% of gdp. By 2014 we will have a surplus, while our trade deficit of recent years has swung into surplus this year - unlike Finland and the Netherlands who have a declining trade balance. We even achieved a tiny trade surplus with Germany in July(!!), the only country in the EZ to do so aside from Ireland with the registered offices of so many German companies.

TARGET2 IS real money... It is money the Bundesbank is lending to the other central banks in Europe. That they're not paper notes doesn't make them less real...
However, I do agree that money IS going from the south to the north, but the simple reason is that this is the way it is in a currency union as money WILL flow from the less efficient countries to the more efficient ones...
There is a very simple example that will illustrate this. Note that it should not be taken literally, but as a general one:
An efficient German makes a hammer. He can sell it at €1.
An inefficient Greek makes a hammer. He can sell it at €2.
A German want to buy a hammer. He buys the German one.
A Greek want to buy a hammer. He buys the German one....
This is not anything to do with the Greek hammer makers efficiency, but that the general efficiency of the country is so much lower because of lacking infrastructure, locked professions, corruption etc.
The way this problem is usually solved in a currency union is by having transfers going the other way via a federal government (US and UK are prime examples), where unemployment benefits, pensions etc. are done by them and not the individual member states. The EZ is lacking that mechanism, and THAT is the fatal flaw in the EZ construction!
Without it, the above money flow WILL continue south-to-north, no matter how many bailouts or reforms are done. The problem will NOT be solved until such a transfer union is established, but I see absolutely no sign that the northern countries are willing to do so.
I saw some pretty convincing figures for it earlier this year which estimated that Germany would have to send between 10% and 20% of their GDP south just to maintain status quo. The German population will simply NOT agree to something like that...
You say Italy is suffering... Sorry, but the suffering hasn't even started yet...
Italy will go the way of Spain and Greece because of those rather simple economic truths about money flows in currency unions.
All bailouts for the southern countries can do is stall the situation a bit, but they can't reverse it, and the south will be locked in a vicious cycle of austerity and unemployment until they break.
The solution everyone is hoping for is either that someone else will pay (they won't), or that growth will resume (it won't as long as the crisis persists).
That leaves the last solution, that of a eurozone breakup, either partially or complete. IMHO this would be the solution that would hurt the least...
Robert Mundell formed his theory of optimal currency areas in 1961... Unfortunately the EZ politicians chose to ignore it...
The EZ countries WERE warned against this before the EZ was created, but any economist who dared say it was ignored and officially shunned by the politicians. THAT is what puts the blame for the mess 100% on the EZ countries!

1) Optimal currency theory has little application in the real world - there are other political factors: such as speculative attack.
Neither the US nor Japan nor the UK represent "optimal currency areas".

2) Obviously the news has escaped you that Italy achieved a (small) surplus with Germany last month as our trade balance has shifted over the last 2-3 years from deficit to surplus. No other EZ country has a surplus with Germany (except Ireland, due to the presence of so many head offices of German companies for tax reasons).
What is Denmark's trade balance with Germany?

3) It may also surprise you to know that, at just over 200 billion euros, Italy is the largest holder German bunds.

Ours is not a competitiveness problem; ours is a political problem triggered by Prime Minister Bunga Bunga (sponsored and supported all these years by the Vatican).

And we have a very high taxation problem provoked by the need to support a high debt load which was mostly run up between 1978 and 1992 by Christian Democratic forces answering to the Pope and bent upon bankrupting Civil State finances to strengthen Church finances.

Italy has 2 trillion euros of debts and Italians have 8.6 trillion euros of private savings. We can resolve our own problems in the medium term - but first the Pope's henchmen, who have followed a deliberate policy of keeping the Civil State weak and/or divided (as in past centuries), must be driven from politics and the parliament.

Those countries are MUCH better candidates for being an OCA than the EZ, that's for sure :-p

And the main reason for BEING an optimal currency area when you have a shared currency is to AVOID speculative attacks (as the countries you mention generally are)!
The EZ is not under 'speculative attack' because of some evil nefarious villains... It is under attack because it has a fatal inbuilt flaw in the euro construction where vital pieces are missing.

Why is Spain under attack and not the UK? The UK deficit is larger than Spain's.
Because the UK is a well-functioning OCA, and Spain is a member of a fatally flawed OCA.

Ref. your point 2...

This is actually quite natural in countries in trouble. What happens is that internal consumption is hit harder than exports since your citizens spend less.

A change like that is actually not a good sign since it also mean that they'll be spending less on locally produced stuff and particularly services too... It also indicates that your industry has stopped investing which is not good either...

I have no knowledge of Denmarks trade balance with Germany, but I expect it to be positive. After all, that's the case with most countries :-D

Ref. your point 3...

Fine. Confiscate 2 trillion then and pay off your debt :-)

Unfortunately your countrymen DO elect those people you blame for everything, which actually mean that the blame is going straight back to them... and thus also you...
Yes... YOU!!!
Being a citizen of a democratic country means that you have taken responsibility for the actions of your government, no matter whether you voted for them or not... That is the basic PRINCIPLE of democracy :-)

The reason the third option (rebalancing) is not doable is not because GERMANY (and others) doesn't want to do it... It is because the GERMANS (and others) doesn't want to spend money on southern goods... There's a distinct difference between the countries governments and their citizens.

It is also after all limited how much olive oil you can use, how much wine you can drink, and how much you want to go on vacation to countries that are striking every other day (or so it seems)...

In the medium-to-long term (though not short term), it would probably hurt LEAST if the euro was disbanded as orderly as possible (and as soon as possible).

" It is because the GERMANS (and others) doesn't want to spend money on southern goods."

Which is of course why Italy is now selling more goods to Germany than Germany sells to Italians, even though there are still 300,000 German autos sold in Italy this year as opposed to just under 90,000 FIATs sold in Germany - of which half are manufactured in Poland.

Sort of gives you an idea of just how massive Italian exports are to Germany in other areas, eh? And, those exports are mostly industrial machinery and machine components.

"In the medium-to-long term (though not short term), it would probably hurt LEAST if the euro was disbanded as orderly as possible (and as soon as possible)."

Obviously you understand little or nothing and have been reading too many Nordic newspapers.
Germany will never leave the Euro and never allow Italy to leave the Euro - because in either case Italian exporters would tear Germans a new arsehole.

Agreed re-balancing is urgently required. Its time for some novel solutions because the current approaches are not working.

Local currencies are a possibility that should be considered seriously. Local currencies circulate in parallel to the official currency and are designed to boost demand in the local economies in which they circulate.

Just a thought, isn't it also time to boost local demand in Greece, Portugal and Spain too?

"... rather than a unified federation with centralized deposit insurance, unemployment benefits, and pensions (and why should they not?)"
Please what? Why should they? Face it: the peoples of Europe view themselves as separate nations sharing a single currency because they ARE seperate nations sharing, unfortunately so, a common currency.
Pls. spare us the endless proposals that the core has to transfer limitless amounts of money to the CluBMed in order to keep the standard of living there on a level these nations can't afford on their own.
BTW, there not enough demand for ClubMed's olive oil, wine and hotel rooms.

"the breakup of the single currency is the most likely course. Compared to the current misery, that would probably be for the best."
I hope you're kidding. This is exactly what politicians who have not thought about the issue for even a moment but want to make waves in the papers say. Please do not give this kind of view any more legitimacy than they currently enjoy unless you have some serious analysis to back it up.

Next thing you know, the end of a Babbage post will end with something like "given the poisonous state of current politics, adding creationism to textbooks would probably be for the best".

I just wonder how much the Euro member states regret their folly in joining the Euro. Giving away the control of your own currency to other countries with no common demos or economic policy was and is madness. Well they were warned and chose to ignore it so my sympathy is limited.
Everyone knows deep down that the Euro is never going to work. It simply can't work. It is just going to be ineresting to see how long it takes for the political class to admit this and start unwinding the Euro to save us all from a disaster. They will surely take longer than they should as there will be qite a lot of blame to go around.

1. Labor mobility. Remittances home will help with the internal balance of payments problems.

2. Labor taxation reform. The "hidden" costs of social taxes make real labor costs too high especially in the periphery.

3. Labor flexibility. Let companies have greater freedom to lay off when necessary. No company wants to make a permanent hire under the current labor regime. The existence of permanent and temporary labor contracts should have been a clue that something was wrong.

4. Wage flexibility. Wages must be in line with international norms of productivity. Labor is international. Jobs go where labor is properly priced - there is no alternative.

One thing is sure: whether the euro eventually collapses or somehow survives, the crisis will persist for many years ahead, with the tendency to deepen further. That's a reality for which is already too late to be changed.

- In the long run, labour markets partially clear - and that will make an enormous contribution to GDP and the fiscal situation in periphery countries.

- European countries are now running structurally balanced or surplus budgets, so the debt path is now sustainable (radically different from, say, Japan).

- we have some big free trade agreements coming on stream; we have the persistent upwards pull from rapidly growing Eastern Europe; we have a high probability that the commodity bubble will crash

- there are only so many more years of budget cutting. Nearly two thirds of the fiscal gap in the eurozone has already been closed - so the impact of fiscal contraction will recede (especially in 2014 and thereafter).

Of course in the long run you will have made a desert where once there was green abundance. Operating, as you do, out of an intellectual closed loop you will ignore the human and economic cost of all this waste and proclaim that all that "uncompetitive" greenery had to go and that it is the desert which provides the only truthful condition for the lives of those few nomads who remain to eke out their hardscrabble existence amongst its wasted acres.

Meanwhile - In the short run overall peripheral output is falling faster than deficits so net peripheral debts are growing not contracting. Real interest rates paid on debt are far higher than the growth of the economy and on even the most rose tinted forecasts this situation is going to get worse not better. Youth emigration figures out of the Baltics & Ireland have exploded. Of course unemployment (the metric you never mention) continues its remorseless rise everywhere. In Portugal, Ireland, Greece and Spain it has grown by 180 ppt since January 2008 – in Spain and Greece it is already at great depression levels (http://www.economonitor.com/rebeccawilder/2012/10/01/unemployment-rate-i...).

Re-structuring by which you mean engineering a smaller economy to support an ever growing debt burden is an act of economic self cannibalisation. As for the long postponed arrival of your confidence fairy – suffice to say that is no more than an infantile fantasy.

Growth is the non-negotiable route to recovery.

Default via devaluation and inflation is the route to growth and recovery. Let the rent seekers pay their long evaded debt to society. Think of it as an overdue write down on all of those artificial earnings previously accrued when all of those "uncompetitive" economies were booming......

That's a little unfair. The first point I made relates to unemployment - both the worst aspect of the present crisis and the best opportunity for an economic boom when emerging from the crisis (just imagine the upwards explosion in consumer spending as unemployment falls from 25% to 15% - a 13.3% employment growth).

Spain does not have to issue debt at high interest - 3.5% is available on long term bailout debt (with unlimited ECB support at far lower rates for shorter terms). In the long run, Spain's nominal GDP growth will actually exceed the average yield it is paying on its debt burden - especially at current debt levels (and even at 90-100%), debt is sustainable. What is not sustainable is the primary deficit and the potential for an uncovered banking bust - and both must be conquered (through actual austerity; through a European banking resolution framework) before the situation can improve much.

You point out the Baltic states - bad example. Yes, there was mass emigration. But unemployment is now collapsing (in the past year, down from 13.2% to 10.1% in Estonia, down from 15% to 12.9% in Lithuania, down from 17% to 15.9% in Latvia) and the economies are growing strongly (GDP growth now looking to be in the 3 to 5% range for all 3 countries). Needless to say, all now have strong public finances. With small open economies coming from low debt levels, pay cuts and sharp austerity worked.

Spain's situation is more complex.
- Credit flight, debt finance and cleaning up bad banks all matter - and Spain ought to get onto a full bailout program for this reason.
- The regulatory barriers to recovery (e.g. flat social charges for anyone registering as self employed; all labour regulation on new businesses) should be eliminated.
- Spain's government must use its limited resources more equitably. Suspend all new state retirements for able bodied persons until the fiscal situation improves, and use the saved funds to pay for apprenticeships/ internships/ subsidised working opportunities/ employment loans.
- Spain should improve tax efficiency. Move to a single VAT rate (elimination of the universal cold food subsidy would shift a large marginal population from kitchen eating to social eating, and create a boom in restaurant/ bar employment). Eliminate corporation tax (allow banks to recapitalise and businesses to cover investment & trading costs and everyone to deleverage - stop discriminating between debt & equity finance).
- Spain should cut its military spending to below Swiss, Austrian or Irish levels. Debt is a bigger national threat than any enemy army - allocate resources accordingly. From 1.1% to 0.5% of GDP. Bread over guns.

Though in truth, while 5.75% (current 10 year bond yield) is macroeconomically inappropriate, it isn't historically unusual or unaffordable as a long term interest rate.

Long term, Spain has roughly 2.5% GDP growth and 2% inflation, for 4.5% nominal growth (which Spain could easily far exceed in the next 10 years, given the depth of the depression from which it will emerge).

A 1.25% real financing cost (for maintaining a steady debt level) will be a painful drag (and a good incentive for cutting debt levels). But it isn't dangerous or unaffordable - it's just something to moan about (so, just cutting military spending to 0.5% of GDP would finance extra debt to the tune of 50% of GDP over the long run). Other things matter much more.

Nonetheless, if long term bailout debt costs 3.5% (or -1% in long term steady debt financing costs), Spain should take it (even if that does mean a decade of external auditing and consistent pressure to undertake liberalising reform).

That's a little unfair. The first point I made relates to unemployment.

Well your statement was – “In the long run, labour markets partially clear..”

In the long run labour markets can certainly “partially clear” – but this occurs after a generation of workers has been needlessly sacrificed (or have permanently emigrated). As they quickly lose skills and working disciplines workers rapidly move from being unemployed to becoming unemployable – at which point they are often re-classified as unable to work and they start appearing in other data sets (such as disability claimants) or they disappear into the black economy or they live off crime (often all three). None of this is good for the aggregate economy in either the short or the long run.

It is also a notably fallacious exercise in reverse engineering to extrapolate an eventual improvement in long run demand emanating from a population group who despite being “cleared” from the unemployment statistics will still continue to subsist within the economy as a permanently destitute underclass.

The final but related point is that whilst the wage competitiveness of the rump of employed workers may temporarily improve (i.e. their wages may indeed start to decline in the medium term) – this wage deflation is not sustainable. After even a few years of mass unemployment you will find that you have simply introduced a different sort of wage uncompetitiveness into your cherished long term labour market.

In the medium term (i.e. long before your promised land of the “long term” is even sighted on the far horizon) wages will rise more rapidly than output even in a context of high unemployment or high non participation (as described above). Because the victims of your short term cull are quickly rendered ineffective and economically non participant they are not able to compete with the employed rump for jobs. Accordingly the future wage demands of the employed are not inhibited by fear of losing the job or of replacement by the unemployed. In fact uncompetitive wage inflation amongst the employed is turbo charged by protracted periods of mass unemployment. An economy can certainly create a large permanent underclass and still suffer from very high rates of wage inflation (look at South Africa). This is called hysteresis in economics – look it up.

So all that your policy preference will have achieved from this senseless purge is to economically disenfranchise millions of people whilst at the same time building greater structural inefficiencies into your remaining labour market. Of course this wage inflation will eventually require renewed purges in order to restore competitiveness and so the mad circular march must go on and on and on, never quite achieving that fabled land of long term stability and prosperity that you keep promising us.

@Shaun39: “Spain does not have to issue debt at high interest - 3.5% is available on long term bailout debt (with unlimited ECB support at far lower rates for shorter terms).”

Of course if Spain had her own currency she wouldn't need a bailout.

But it’s also true that even as a euro captive Spain has to apply for a bail out first. She is reluctant to do that – additional conditionality imposed on a country that is rapidly approaching disintegration due to the devastation caused by her existing programme of imbecile austerity would be political suicide for Rajoy. For its part the German leadership are crowding the airwaves saying that Spain shouldn't apply for a bailout. Merkel lives in dread of having to present another monster bailout to the Bundestag.

It appears that the German solution to Draghi’s “unlimited” monetary put option is to sabotage any situation in which it can be exercised.

@Shaun39: “You point out the Baltic states - bad example. Yes, there was mass emigration. But unemployment is now collapsing (in the past year, down from 13.2% to 10.1% in Estonia, down from 15% to 12.9% in Lithuania, down from 17% to 15.9% in Latvia) …

Give me strength!

What correlation can you draw between mass emigration (as you yourself put it) and falling unemployment rates? Let me suggest a small clue to help you on your way: If a large swathe of your working population is no longer resident (and therefore no longer on your unemployment roll) then your much trumpeted fall in unemployment is simply an artefact of the sharp contraction in the size of your working population rather than the outcome of new austerity created jobs (now there’s an oxymoron for our times!).

And, as you are our spokesman for the overriding importance of the long term, what does it tell you about the long term viability of an economy (already experiencing demographic pressures) that has suffered a substantial (and probably permanent) fall in its working population most of it from its youngest cohort?

So, by your account, five weary years of Baltic austerity have delivered a smaller working population (and a permanent reduction in potential economic capacity) an economy that is still between 6 & 10% smaller than it was in 2008 and unemployment in the high teens.

Unemployment fell - both through emigration (to well paid jobs in Western Europe) and through increased domestic employment.

For the Baltic states, with little national debt, population and GDP don't matter much - it's productivity, GDP/ capita, incomes, unemployment and tradables as a proportion of GDP that matter. And on all those counts, the situation is rapidly improving.

People matter - countries don't. Migration flows between countries is one of the few good things to come of this crisis (I speak as one of the young migrants; with friends from every large European country).

Merkel isn't seeking re-election. In that respect, she is not really constrained by popular opinion. She has however built her whole career through compromise and negotiation between interested parties.

She never was a leader with ideals or principles - she's just especially skilled at getting people to work together and reaching outcomes that are as widely acceptable as possible (among influential parties).

That there is an alternative to reducing spending and raising tax revenue?

Absolutely, unemployment should be one of the top priorities in Spain, and needs far more political attention than it's getting. You won't find me defending Rajoy's broad economic policy (and complete failure to push through necessary reforms and employment creation schemes).

That's quite separate from austerity.

In any case, all the points in the first post above stand. Spain will emerge from this crisis with far more rapid and robust growth than, say, the US or UK. Thanks to large reserves of unused labour and capital, which will mostly find employment over the next 5 years.

That isn't to say that the present situation is acceptable; it is needlessly damaging many lives, and may well have some negative impact on long run outcomes. Nonetheless, this is pretty powerful evidence against those who claim that there is no recovery in sight. There is, it will be here by 2016 at the latest, and it will be massive (doubtless, with yet more froth & bubbles).

Social inclusion objectives are separate, and don't in any way conflict with austerity. It's just plain incompetence and insensitivity that has led the government to waste scare expenditure on white elephants, early pensions and other madness, where it would be far better spent on apprenticeships, internships, small business employment loans or other such measures to reduce inequality where it is sharpest.

"So all that your policy preference will have achieved from this senseless purge is to economically disenfranchise millions of people whilst at the same time building greater structural inefficiencies into your remaining labour market. Of course this wage inflation will eventually require renewed purges in order to restore competitiveness and so the mad circular march must go on and on and on, never quite achieving that fabled land of long term stability and prosperity that you keep promising us."

This is a terrifying prospect. In theory, the EU has been spending billions on professional training programmes to avoid exactly this sort of outcome.
I am very worried about the increase of the retirement age to 67 and beyond: who is going to hire an unemployed 60-year-old? Who wants to keep a 60-year-old in the office, as their eyes have difficulty reading the computer screen?

And yet, there is no question reducing the debt and deficits must continue.

Personally, in Italy's case, I conclude our gold must be sold (traded to the ECB in exchange for their holdings of our bonds) and a new wave of privatisation must be carried out. And, spending on non-growth-related (improvement of infrastructure) items must be further slashed - Italian pensions are eating up 16.6% of gdp - this is clearly unsustainable.

shaun39 wrote: “Unemployment fell - both through emigration (to well paid jobs in Western Europe) and through increased domestic employment.”

1. The export of skills sufficiently high to obtain “well paid” jobs in western Europe is a net loss to the current and future economic potential of the Baltics. This is not the great Baltic success story that you have claimed.

2. The fallacy of composition applies here. Even In your “people matter not countries” world we all inhabit a single closed economic system (the world). It therefore follows with an elegant inevitability that exporting more people to western Europe means that the people who inhabit “Western Europe” must pay the price for failed Baltic policy in lost job opportunities. There is therefore no net gain for the “people” of the world any more than there is any net gain for the Baltic “nations” or the Baltic “people”.

The only entries you can make in your grim ledger are in the losses column – loss of Baltic jobs, output and capacity.

So….as long as the fall in the numbers of the working population is greater than the fall in GDP then you are perfectly satisfied that the Baltic policy is “working”. What criteria for economic welfare did you use in framing this idiot doctrine? Certainly your criteria could comfortably accommodate a claim that both the Irish famine and the Scottish highland clearances were outstanding economic achievements.

@Shaun: “incomes, unemployment and tradables as a proportion of GDP that matter. And on all those counts, the situation is rapidly improving.”

You are celebrating a smaller economy and a smaller population. In the real world this is not a cause for general celebration. Liquidate the population by liquidating the economy – a brave new paradigm.

@Shaun: “People matter - countries don't.”

A complete non sequitur . Countries matter a great deal to people - or they wouldn't exist . I assume that you are aware that countries weren't created by aliens.

@Shaun: “Migration flows between countries is one of the few good things to come of this crisis (I speak as one of the young migrants; with friends from every large European country).”

A world of nomads – how romantic!

Europe re-engineered – An ever growing pool of rootless scavengers serving an ever contracting pool of settled rent seekers. How stable an entity do you think this will be?

@Shaun: “Merkel isn't seeking re-election.”

That is certainly a categorical statement – it is also completely false.

@Shaun: “What are you actually trying to say? That there is an alternative to reducing spending and raising tax revenue?”

I am saying that growth is the only way these debts can be serviced much less repaid. I am saying that reinforcing the existing collapse of private demand by engineering a simultaneous collapse in public demand will result in both mass destitution and debt default – the worst of all outcomes. I am saying that market confidence cannot (by definition) be restored by an austerity policy that is so hostile to recovery and growth.

I am also saying that converting catastrophic private commercial failures into public liabilities is socialism for the rich and an act of mass expropriation for the poor. These public subsidies now need to be repaid by those who have benefited from them. Their assets cannot be permanently protected from the consequences of the incompetent management of their own agents. Plundering the taxpayer to protect the bondholder is an inversion of the proper priority. Any future austerity must be imposed (in the form of a haircut) on the assets of bondholders and not on the blameless taxpayer or the ever growing army of the unemployed.

I am saying that devaluation and inflation will protect and stimulate the productive economy and redirect wealth from unproductive savings back into productive investment. Wealth that isn't constructively employed will be erased via inflation. This is as it should be in a market economy. The risk free asset does not and cannot exist in a free market and the moral hazard created by pretending it does has become a weapon of mass economic destruction.

I am also saying that the strength of a currency must reflect the strength of the underlying economy it serves. Trying to re-engineer an economy around a fixed currency value is demonstrably insane. I am also saying that those who refuse to help their partners in the common currency need not anticipate enjoying a future share in the common market.

"However, this country imports hundreds of tons of fresh goods every year, including fruit and vegetables that are easy to grow here such as oranges, lemons, apples and potatoes, as well as basic meats and tons of fish from all corners of the world. Last year, we even had imports of olive oil from Germany.

[...]

Greek producers meanwhile -- the spoiled children or victims of a system that does not account for the needs of the market -- have become accustomed to ignoring quality and opting for quantity that will bring in subsidies. Typical examples of this behavior are the majority of farmers in Laconia in the Peloponnese, who allow their oranges to fall off their trees and rot rather than sell them at a low market price, as they have become accustomed over the years to receiving subsidies for their juice oranges, irrespective of quality. Now that the subsidies have dried up, Laconia oranges pale in comparison to the competition and can no longer secure a foothold in the market."

"How many times have we heard that the Germans refuse to tolerate any reductions in their massive trade surplus?"

Irrelevant. They would have to if the peripheral countries could actually come up with regulations, institutions and infrastructure that encourage growth.
It's no wonder the core doesn't buy a lot of the periphery's goods when those goods are "olive oil, wine, and hotel rooms." The real problem is that the periphery isn't particularly good at making goods the rest of the world wants, not that the Germans aren't buying it. That's what needs to change. The rest will follow.

I'm always puzzled that the lesson drawn from the EZ's internal imbalances is that the core's export business needs to get worse rather than that the periphery's export business needs to get better. It would certainly be easier than the alternative, but it's a shitty solution if I ever saw one.

Regarding balance of payments July 2012 has recorded a positive number for the first time since before the euro (actually since the early 90s). In both goods and services. I dont care whether the germans buy these goods and services or not (although I assume they do at least in part) but I agree it will be just great if they spent their meagre wages in here and start having a bit of fun (God knows they absolutely need it).